US Treasury debt prices fell on Wednesday after August retail sales showed underlying strength in the US economy that suggested the Federal Reserve will press on with its program of interest rate hikes.
Short-term rate futures showed as much as an 86 percent chance that the Fed will raise rates by one-quarter percentage point at the next monetary policy meeting of its Federal Open Market Committee on September 20, up from 82 percent on Tuesday.
Nervous selling was also seen ahead of Thursday's August report on the consumer price index, which is the broadest measure of US inflation.
Despite a benign reading on US producer prices on Tuesday, dealers were concerned that the CPI report could show that high energy prices, especially for gasoline, are being passed through to non-energy items.
Wall Street forecasts for a 0.2 percent rise in core CPI, stripped of food and energy costs, would be the biggest increase since March.
"If the core CPI comes in at 0.3 percent, the market should dismiss the notion of the Fed pausing at any of the remaining FOMC meetings this year," said Brian Robinson, bond strategist at 4CAST Ltd.
The 10-year Treasury note fell 9/32 for a yield of 4.16 percent, up from 4.13 percent on Tuesday. The next target for the benchmark yield is 4.20 percent.
Selling spilled over from Chicago Board of Trade futures after the Treasury Department said it would step up monitoring of the cash security that is cheapest to deliver against the expiring September 10-year note contract.
The announcement suggested regulators are watching the cash and futures markets closely to prevent a repeat of the so-called squeeze in the June 10-year contract, which drove futures prices up sharply at the time.
The Treasury called for entities that hold large positions - $2 billion or more as of close of business on September 12 - to reveal this by September 20.
"They are trying to make sure they have a well-managed marketplace, and light is the best disinfectant," said Bob Griffin, a bond broker at the CBOT. "It might be depressing prices mostly because the market is slow today."
The two-year/10-year spread steepened to 28 basis points from 26 basis points as news of the Treasury intervention hit longer maturities.
Bonds fell initially when the non-auto portion of August retail sales was stronger than expected, suggesting the US economy was in better shape than some had thought before the onset of Hurricane Katrina.
The 30-year bond fell 17/32 to yield 4.44 percent, up from 4.41 percent. CBOT 30-year futures are holding at the 50-day moving average, keeping a cap on cash yields.
Five-year Treasury notes were down 4/32 at a yield of 3.95 percent, up from 3.93 percent.
Two-year note yields were at 3.89 percent, up from 3.86 percent.
A strong CPI reading risks a rise in the two-year back to 4.0 percent, dealers said.